Gaia, Inc. (GAIA) Q1 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Gaiam 2014 First Quarter Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, May 8, 2014. I would now like to turn the conference over to Norberto Aja, Investor Relations. Please go ahead.

Thank you, operator, and good afternoon, everyone. Thank you for participating in Gaiam's 2014 First Quarter Conference Call. Joining me today on the call are Gaiam's Chairman, Jirka Rysavy; Gaiam's CEO, Lynn Powers; and Steve Thomas, Gaiam's CFO. Following some prepared remarks, we will open the call for your questions. But before we get started today, I'd like to take a minute or 2 to read the Safe Harbor language. The following constitutes the Safe Harbor statement of the Private Securities Litigation Reform Act of 1995. Except for historic information contained herein, the matters discussed on this call today are forward-looking statements and involve risks and uncertainties, including, but not limited to, general business conditions, integration of acquisitions, timely development of new business, impact of competition and other risk details from time to time as described in the SEC reports. The risks and uncertainties associated with the forward-looking statements are described in today’s news announcement and in the company’s filings with the Securities and Exchange Commission, including the company’s reports on Form 10-K and 10-Q. Gaiam assumes no obligation to publicly update or revise any forward-looking statements. Today’s call includes non-GAAP financial measures within the meaning of the SEC Regulation G. When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measures, calculated and presented in accordance with GAAP, can be found in today’s press release, as well as the company’s website. With that, I would now like to turn the call over to Gaiam's Chairman, Jirka Rysavy. Jirka, please go ahead.

Thank you, Norberto, and good afternoon, everyone. Revenue for the first quarter, which ended March 31, was $37.6 million. This represent about 3% comps on top of 28% over the first quarter of 2013. Gross profit grew to $17 million from $15.7 million, and gross margin improved 240 basis points to 45.3% from 42.9% in the first quarter 2013. Operating loss for the quarter improved 21% to $2.5 million from $3.2 million in last previous year quarter. During the quarter, we secured a placement of another 1,400 new branded store-in-stores, which is a very nice addition to our existing 15,000 stores-in-stores. The shipments to those stores will start in the third quarter of this year. Our overall inventory turns also started to improve. Our video subscription business keeps, again, progressing very nicely. GaiamTV generated revenue of approximately $5.6 million in 2013, and we still expect the revenue to at least double in this year. Current revenue run rate is over $10 million, and it's driven by over 6,000 videos. Over 90% of these videos are available exclusively on GaiamTV for streaming through virtually all devices connected to Internet. Recently, we implemented a new recommendation engine and also launched a new app for Amazon Fire TV. We are also planning to launch a new feature for our subscribers that will provide an unlimited secure download to all subscribers to keep on -- for them to keep the content on their devices as long as they pay the subscription fee. If they stopped paying, that content will become unusable. The operating loss for the GaiamTV unit for the quarter was about $2.3 million. We believe that the proposed separation, as we talked last time, of GaiamTV, which we now expect to occur in the fourth quarter of this year, will unlock some additional values for shareholders. And with that, I'd like to turn it to Steve to talk to you about financials. Steve?

Thank you, Jirka. I'll spend a few minutes reviewing the financial results in greater detail and offering additional perspective on the performance for the quarter. Let me begin by reminding everyone that the results we reported earlier today and that we will discuss on this call do not include any contributions from GVE, our former non-Gaiam-branded entertainment media business, nor do they include contributions from our discontinued direct response television marketing operations. We now report these businesses as discontinued operations, and all figures reflect our continuing operations, which are comprised of our branded yoga, fitness and well-being business, our e-commerce platform and GaiamTV, our digital video subscription business. I'd like to note that in the fourth quarter of last year, we made a change to how we operate our third-party fitness media category management. Instead of purchasing media products from third parties, owning the inventory and tying up cash flow, we converted these products to a distribution model. Under this model, we no longer record the sale of the media's revenue, but instead recognize our distribution fee on each unit. This change reduces our revenue but increases our gross margin. We do not take ownership of the inventory, thereby reducing working capital and improving cash flow. Had we made this change in the first quarter of 2013, we would've recorded approximately $1 million less revenue in that quarter and our revenue growth on a comparable basis would have been over 5% for the first quarter of this year. Beginning with the income statement, net revenue for the first quarter of fiscal 2014 was $37.6 million, an increase of approximately 2.5% or $1 million compared to $36.7 million in the prior year period. The performance of our business unit was in line with our expectations. And we were pleased with the growth in our top 25 accounts. The direct-to-consumer business grew 17% compared to the same quarter last year. Gross profit for the 2014 first quarter grew to $17 million or 45.3% of net revenue compared to gross profit of $15.7 million or 42.9% of net revenue in the first quarter of 2013. The increase in gross margin reflects the growth in GaiamTV and the change to our media category management business that I just mentioned. Operating expenses totaled $19.5 million or 51.9% of net revenue in the first quarter of 2014 compared to $18.9 million or 51.5% of net revenue in the first quarter of 2013. The slight increase in operating expenses was due to the ongoing investments around GaiamTV. Operating loss from continuing operations for the 3 months ended March 31, 2014, was $2.5 million compared to $3.2 million in the first quarter of 2013. The improvement in operating loss reflects a reduction in expenses compared to the first quarter of 2013, offset by increased marketing and selling by GaiamTV. During the quarter, we recognized an income tax expense of $0.1 million, compared to a tax benefit of $1 million in the first quarter of 2013. Although we had an operating loss during the quarter, we did not recognize a tax benefit because of a valuation allowance we took against our net operating losses in accordance with GAAP, similar to the fourth quarter of last year. When we post operating income in the future, we will reverse the valuation allowance and be able to recognize further tax benefits in our financial statements. In future periods of profitability, the reversal of the valuation allowance will offset income tax expense in those periods. As a result of the tax expense this quarter, our loss from continuing operations was flat at $2.1 million compared to Q1 of 2013. In addition, during the quarter, we recognized a gain of $0.4 million on the sale of shares of Real Goods Solar. Moving to the bottom line, net loss for the quarter was 20 -- $2.1 million or $0.09 per share compared to a loss for 2013 of $0.3 million or $0.01 per share. The decline was primarily attributable to the tax valuation allowance that I previously mentioned and the results from the discontinued operations. Taking a look at the balance sheet, we ended the quarter with total cash of $29.5 million and no debt, compared to cash of $7.1 million and $8.3 million of debt at March 31, 2013. Our current ratio at March 31, 2014, was 3.4, a metric that continues to reflect the health of our balance sheet and our ability to fund our growth. Inventory turns improved to an annualized rate of 4.1x in the quarter from 3.3x in the first quarter of 2013. We made investments in PP&E of $0.7 million and media rights of $0.5 million in the quarter. The majority of these investments were for GaiamTV. Depreciation and amortization was approximately $1 million for the quarter. In summary, we have a healthy and robust balance sheet, including a good cash position and no debt. Additionally, our position in the fast-growing yoga, fitness and wellness marketplace helped drive a 7% year-over-year growth with our key retail partner relationships during the quarter. Taken together, our financial and strategic resources will enable us to invest for both organic and acquisition-based growth initiatives going forward. With that, I'd now -- I'd like to now turn the call over to Lynn. Lynn?

Thanks, Steve. Overall, the performance of the quarter was in line with our expectations. Excluding the impact from a recent security breach at our largest customer and the conversion of our media category management business that Steve mentioned, our 25 largest customers in our business segment [indiscernible] double-digits on top of a comp in excess of 40% in the first quarter of 2013. Our direct-to-consumer business segment grew 17%, showing the strength of the brand and the category. Last quarter, I covered 4 of our primary initiatives for the year. Those were expanding stores and store placement for Gaiam and Gaiam Restore, expanding distribution for our SPRI brand, improving our e-commerce branding and performance, and refocusing on delivering innovation. I would now like to review our progress on these initiatives, outline how we plan to continue executing on them going forward, and give a preview of our growth plans for 2015 and beyond. Gaiam Restore, which we launched in 2012, addresses the growing consumer demand for preventative, restorative and stress-relieving solutions. The line has become a hit with some of our largest accounts and has allowed us to add new accounts, such as Walgreens. We added enough SKUs to the line in order to build a 4-foot store-within-store. I am pleased that during the quarter, we secured placement for an 8-foot store-within-store set of Gaiam yoga and Restore products in an additional 1,200 domestic doors for delivery beginning in third quarter. One of these wins was part of a larger expansion that added 8 feet of product to our already-existing 12-foot store-within-store. We also included Restore in the launch of Gaiam product in one of the largest international retailers, with 220 stores setting in the second half and an opportunity to expand to more of their over 3,000 doors. During the quarter, we also continued launching SPRI in the retail market. We recently received a commitment to place SPRI products with one of our largest customers in over 1,500 doors. This commitment will allow us to replace products under a third party brand, which we licensed, with products under SPRI, a brand that we own. The commitments I just reviewed, which will benefit our financials in the second half of the year, reflect our ability to drive growth, both through our existing 38,000 retail relationships, but also through new accounts. With respect to our catalog and e-commerce business, we launched a new site, Gaiam Pro, that will enable us to better connect with the yoga and fitness studio and practitioner market, a key step in growing our brand presence within these highly influential channels. As we have reoriented the company around our branding strategy of yoga, fitness and well-being for everyone, we are redesigning the Gaiam.com website, with a targeted launch at the end of the year. We also planned the launch of redesigned SPRI.com website in the third quarter. Recently, we decided to reduce our catalog circulation further, in part due to the 4.8% rate increase announced by the U.S. Postal Service. Our goal is to carefully reduce spending on our catalog so as to maintain our customer relationships, while shifting them online, and using social media and email marketing to expand our consumer reach. Finally, I'm excited to share some of the early progress from our renewed focus on product innovation. On the accessories side, we're putting the finishing touches on a new Balance Ball Chair. This evolution of one of our strongest-performing products will reflect our effort to bring style to the accessory market, while maintaining the high performance our products are known for. Expect to see this product on Gaiam.com in the fall. We're also continuing to add new product innovation to our SPRI and Gaiam lines, with technology innovations in mats, new product ideas for SPRI Cross Train, and additional solutions for Gaiam Restore, such as back care and compression. We will also launch Gaiam kids and men's yoga accessory lines by the end of 2014. Our success during the last 12 months is reflective not only of our brand and product marketing, but also of healthy growth in the yoga industry. From 2008 to 2012, the number of yoga practitioners grew 25% from 16 million to 20 million. During that same time, spending on yoga products and services grew 75% from $5.7 billion to $10 billion. The fact that the yoga market is growing in number and in wallet share means that retailers want to make sure that yoga, fitness and well-being is a strong segment of their offering. And while the playing field is attracting more attention from newcomers, we're confident that Gaiam has a clear and significant competitive advantage, thanks to our deep experience, authenticity and our emphasis on specialized products. Based on consumer research, when it comes to yoga, Gaiam's the second most recognized yoga brand overall and the most recognized brand in non-apparel yoga products by twofold. When we look to the future, for 2015 and beyond, we see 2 major areas for growth of the brand beyond our current product assortment and the innovation that I outlined previously. The first area that we mentioned on our last call was apparel. We have done quantitative and qualitative research regarding the Gaiam brand and found that we have great recognition and consumer permission to go into apparel. We believe there is room for a mid-tier studio-to-street yoga apparel line that can be sold through our retail partners and online through gaiam.com. We've assembled a strong apparel team, which is actively developing the line, and we will launch the collection online this fall with an anticipated expansion to retail partners in the first quarter of 2015. We're also investing in international expansion. The Gaiam brand has demonstrated success in Australia and Canada, in a similar fashion to the U.S. We've recently brought in an expert in the European market to help with the launch of our brands in Europe and expand our assortment in John Lewis, our tent-pole account in the U.K. As I mentioned earlier, we just recently received test orders for 220 doors of an over 3,000-door European chain. We are actively pursuing international expansion because we believe that Gaiam has the ability to be the global brand for yoga, fitness and well-being. In summary, we see many growth opportunities in the second half and moving forward into 2015. We believe in the initiatives I have just discussed because they leverage the tremendous value of our brand across all distribution channels, the unique resources and distribution we have around yoga, fitness and well-being and the opportunity to become the unified global brand in the market. With a compelling array of products and a fast-growing market segment, a more focused business, stronger balance sheet and an improved operating structure to execute on our growth initiatives and gain market share, we're confident we can leverage our brand across our existing 38,000 doors of distribution and 15,000 store-within-stores, as well as expand with new partners, markets and geographies. We believe the separation of GaiamTV from Gaiam will benefit both the businesses themselves, as well as our shareholders. GaiamTV posted strong revenue gains during the quarter, and we continued to invest in the business ahead of the proposed separation. I want to note that all of the video titles that were created by Gaiam will stay under its stewardship, post separation, except for streaming video on demand, which will be offered by GaiamTV. This way, Gaiam will continue to monetize our fitness media content via DVD, digital download and the rental channels. Overall, the decision will further enable each of our 2 companies to independently focus on its strengths and opportunities and will provide a higher degree of transparency to customers and investors. Looking forward, I'm confident what the Gaiam brand is bringing to consumers and the connections we are making with them. I like where we are, but better yet, I love where we're heading. This concludes our prepared remarks, so I'd like to turn the call back to the operator. Jennifer?

[Operator Instructions] And our first question comes from the line of George Kelly.

2 questions from me. First, for Lynn. You commented that there was a slowdown in retail spending to start the year. I'm wondering if you could talk about how it's trended recently? And then secondly, for Jirka, could you go through some of the normal TV business metrics that you give out, such as number of subscribers and expected investment for this year and conversion and some of those numbers?

Sure, George. Well, first of all, yes, I think we were affected, as was everyone, with the cold weather in January and February. And ours was probably compounded with the security breach that happened at our largest customer and the slowdown in business there. But we're certainly seeing that turn around, particularly at our largest customer, where I think the consumers are regaining their trust in them.

We've -- on the matrix, we provided data for April -- for March on the last call, because it's less than 2 months, so we really have only 1 month. So the matrix is pretty much the same. The conversion is about the same. It was, before, mid to high 70s. This never really changed. We probably added for the months what we didn't for April, between the reporting you might add like 5,000 customers, but it's basically all the matrixes are same because there was no reduced -- enough distance between the calls.

And our next question comes from the line of Eliza Buddenhagen.

So there's a lot of discussion about the size of the yoga market and its potential. How does that impact your strategy in terms of pursuing athletic and fitness products versus yoga products? Do you see equal opportunity in both? And what sort of growth can we expect from Gaiam for its yoga-related products?

Well, first of all, the studies that I've seen, yes, they show tremendous growth in yoga. I talked about it in my prepared remarks. But what we've also seen in some of the surveys is that yes, there's 20 million people doing yoga now but there's 80 more million people who are willing to try yoga if they felt it was more accessible. So we see not only a growth in wallet share with more people spending more money on yoga, but also the opportunity to bring a lot more people into yoga with a changing demographic, hence, launching our men's and our kids yoga lines. So we put -- we're certainly putting an investment in maintaining our dominance in the yoga products industry, but also adding apparel to it. We also think that there's opportunity in the overall well-being market, which is just starting to take off and where we're seeing huge growth in our Gaiam Restore line. It also opens up additional distribution channels for us in drug and grocery. So that's also a large opportunity. And then, our SPRI products complement that by having unique and specialized professional-quality home fitness, including specializing in the ever-popular Cross Train or Cross Fit market.

Okay. And how are some of the larger players in the athletic apparel and accessories industry like Nike and Under Armour impacting your market share, if at all?

They're not at all. They're really not in the equipment business. And as we expand into apparel, we'll see how that translates. But we certainly have the authenticity, and our apparel will be street-to-studio, and it will be kind of designed by yogis for yogis.

Okay. And will you have -- did you have a given unrealized gain on the sale of the Cinedigm stock, or will you?

We mark that to market through equity every quarter, so there will be an economic gain there. And then we also still have shares of real goods that will generate gains because we have no book value in those shares.

[Operator Instructions] And our next question comes from the line of Mark Argento.

Just talking a little bit about apparel, Lynn. It sounds like you're well on your way to developing kind of that mid-tier line. Can you talk a little bit about your thoughts about your go-to-market strategy? When can we see product hit the shelves and how big of an opportunity is that for you?

I think you know the size of the industry is huge. It's about an $11 billion industry. And we believe that there won't be any one doing it exactly the way we are. There's a lot of people doing it direct-to-consumer, such as lululemon and Athleta, and then there are smaller companies selling out through retailers. But they certainly don't have the brand recognition that we do. So we hired a design firm. We brought in fit experts and now we have an internal apparel team as well, from such companies as Nike and Spyder. And we expect to have our first product hit Gaiam.com in the fourth quarter, and then we will launch out into the retail market with a launch partner in spring. And we'll certainly look to our current partners to be our first launch partners, the ones that are supporting us in the yoga accessory area.

Got you. And so you see this line going into -- it could be sporting goods, as well as maybe more mass as well, mass retail?

We would certainly start in the sporting goods channel, Mark. We think that's where the biggest opportunity exists. And certainly, when we go into those stores, we see a lot of great athletic apparel, but not a lot of specific yoga apparel.

Got you. And then shifting gears back to the fitness products business. You had mentioned SPRI seems to have some decent momentum. Is there a potential to bring that to some of your larger customers, that line in particular?

Absolutely, right now...

Like in Target?

Yes. And we will be putting SPRI in all Target stores under the IGNITE brand in September of this year, replacing our licensed product in the Reebok -- under the Reebok brand.

Got you. Okay. That's helpful. And then, one for Jirka. GaiamTV, any thoughts on -- I don't know if you quantify, I don't think you quantified kind of the -- you quantified the revenue run rate for that business. But in terms of the spend or the burn in the quarter, is that continuing to taper?

Yes. I mean, we have a couple of projects right now, as I mentioned, what we launched or launching. So the burn for this quarter was $2.3 million and will probably be on the level of about $2 million next and will taper dramatically in the fourth Q. But one of the things, because we are amortizing the acquisition of My Yoga into the P&L, the customers all the way through to the third quarter, so that's what's causing the numbers being bigger. It's not affecting EBITDA, but it's as the P&L, it's the part of $2.3 million. And so they will drop in the third Q so you'll see dramatic improvement in the fourth quarter.

And our next question comes from the line of Robert Routh.

[indiscernible] that you're playing, I'm curious if you have any sense at the moment as to what the capitalization of each of the entities is going to look like, as far as how much cash you're going to put at GaiamTV and what you're going to leave at Gaiam and the NOLs, how we can look at that, how that's going to be allocated once you do this? Or do you -- not sure yet?

We going to actually look at it. We have some outside people involved in that. But basically, the NOLs, they kind of have to follow the assets, so they pretty much will be where the assets were generated, which will come -- the allowance of the NOLs will come obviously with that. And the rest of the assets, we were going to look at the cash and the rest of it, we probably will look monetizing the other stock before we split it, and then we kind of look in the opportunity between now and the time of the split. So it's not decided yet, but we would definitely make sure that both sides are funded in such a way that they don't need to raise any money.

And also remember, Rob, that we have our corporate facilities here that we have not yet monetized, that over the next 12 to 18 months, we will continue to look to see if that makes sense for us.

Got it. Great. Okay. And as far as going forward, obviously, you made a lot of changes, simplified the business [indiscernible] value, your balance sheet is clean, and you have NOLs to shield taxes. So it's kind of good to [indiscernible] your operating income could be actually lower than free cash flow going forward. So that being said, what are other strategic things that you haven't done yet do you see as potential opportunities for Gaiam and the brand given what you have? Is there any opportunity in the education market at colleges and universities, gym classes or health and wellness classes with physical rehab market for senior citizens that's go and do physical therapy after a procedure. Because I would think that with what Gaiam has, that will be a turnkey for a lot of these type of entities that are right now kind of doing it differently, and there could be a lot of opportunities outside of the box [indiscernible]. Could you give us a sense of what you're thinking we're missing?

Well, the issue we have is so many of those opportunities, more that we need to focus. So we're talking more a lot, and I'll let Lynn talk about it.

Yes, yes and yes. We see all of those as certainly opportunities. The Gaiam brand, based on our consumer research, has the permission to go into apparel. It has the permission to go into classes. It has authenticity and is well-respected and well-recognized by the consumer. So what we're doing now is prioritizing those opportunities. And as I said, the first 2 that we believe which will add the most value for shareholders are apparel and international. But all of those things, such as classes [indiscernible] and the rehabilitation market. And certainly, addressing well-being for all demographics are all things that are on our agenda that we will prioritize in the coming years. And also, SPRI already does this. They already -- we already have that trainer world covered. They all -- we were in the professionals market through our SPRI brand. We will continue to try to expand that into the Gaiam brand and address more of the programming part directly to the consumer.

Okay, great, great. Yes, I would think there's a ton of opportunities for what you guys have that people don't even think about. Just a question of how [indiscernible] your resources and when, given you want to do things the way -- maintain the value there, so I totally get it. Great. And the last question is, how should we value Gaiam? When investors look at it, buy side or sell side, obviously, you guys have your own sense of how it should be valued and looked at. What do you think is the best metric, kind of each business separately, discounted cash flow, a multiple of consolidated? Can you kind of help us in terms of how we should look at it for evaluation?

Well, I mean, this one is easy. This is kind of your business not ours. But it's, as we kind of look at it, we kind of look at the Gaiam as a brand. So I think that's 1 value. Second is the GaiamTV separately. So you can kind of look at those multiples. They're kind of different, but each business is valued [ph]. So I think -- and third increment is basically look at the cash, the investments, real estate, maybe NOLs, kind of as the third bucket, which is not typically, put it, -- it depends on how you look at it. If you look at it as enterprise value, obviously, you can keep cash wherever you keep it. But this is how we look at it.

Okay, great, great. And just one more, and then I'll release the question. As far as -- did I hear you correctly, as far as when you create GaiamTV, you're going to keep the titles at Gaiam when it comes to everything else? So GaiamTV will basically only have the streaming rights for that, but as far as all other sales of those titles in different windows or through different mediums that will stay at their core Gaiam company? Am I correct, and did I hear that right?

Yes, what Lynn says, everything that was produced by the Gaiam, the yoga fitness, that will stay in Gaiam, we'll just have streaming rights. But however, from 6,000 titles, what GaiamTV has, that represents only about 500. So what we have on GaiamTV, there's other titles in Gaiam that's not on GaiamTV. But from about -- let's maybe even say everything that we have, it's maybe 700, 800, but let's say, 5,000 of 6,000 is not. Those are independent titles in GaiamTV.

[Operator Instructions] And we have a question from the line of Charles Orenski [ph].

I noticed that you're keeping your yoga online website. Are you guys going to integrate that? Or how is that one doing versus the GaiamTV? And is one trending better than the other? Or are they going to all become 1 at one-time or how's that working out?

My Yoga online will be integrated in August into GaiamTV.

Is my -- how is the traction, one versus the other? Is it similar or?

We don't track it that way.

Okay. You guys are doing really well. You're in a lot of stores, you do $150 million in sales basically. Why is there no profitability? You have high gross margins, but yet, your operating expenses, you don't pay any rent because you own your buildings. Why are you -- I would think you guys could make a dollar a share. Just why are your operating expenses seem so high?

I think the question is way too general. I think -- we never really talk, so I really don't know what are you kind of thinking. But I don't know how to answer this general questions. But it's obvious that what we try to do right now is streamline expenses. So you will see dramatic improvement during the second part of the year. We said it in the last call, if you'll listen to the last call, that you would kind of know the answers.

Right, right. No, I did listen to the last call, when you said you're going to be moving to profitability and your sales are excellent. I just -- and I know it's -- I was just curious when that's all going to happen. But it looks like it's going to be the end of the year, and that's good. So...

You're going to probably see very kind of in line losses we have right in the second Q and then you see big improvements as kind of every year.

Okay. So the expenses that you're putting in with the TV, those will all be pulled out of the retail business in the Gaiam, right? Those will all go over to the new company? And will that be substantial?

Well, I believe that we announced what the loss was for GaiamTV for the quarter.

Yes, $2.3 million loss will disappear from Gaiam for the quarter.

And there are no further questions on the phone lines at this time. I'll turn the call back to yourself [ph].

Thank you. We thank everybody being with us, and we'll talk to you next quarter. Thank you.

And ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.